15) Nico Trading Company must choose its optimal capital structure. Currently, t

Question

15) Nico Trading Company must choose its optimal capital structure. Currently, the firm has a 20 percent debt ratio and the firm expects to generate a dividend next year of $5.44 per share. Dividends are expected to remain at this level indefinitely. Stock- holders currently require a 12.1 percent return on their investment. Nico is consider- ing changing its capital structure if it would benefit shareholders. The firm estimates that if it increases the debt ratio to 30 percent, it will increase its expected dividend to $5.82 per share. Again, dividends are expected to remain at this new level indefi- nitely. However, because of the added risk, the required return demanded by stock holders will increase to 12.6 percent. Based on this information, should Nico make the change? a. Yes b. No c. It’s irrelevant d. Not enough information ****Note**** The answer is not (d. Not enough information) It has to be something else!

Explanation / Answer

15)

Nico should not change the capital structure as it increasing the expected dividend. If the expected dividend is increased, cost of equity will increase. It leads to increase in required rate of return.

Hence, correct option is (b) No.

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